Index Wrap, Wednesday, 01/12/2005

Intel overshadowed by trade figures

by Jeff Bailey

A final hour spat of buying had the major indices finishing with
gains as the Dow Industrials (INDU) 10,617.78 +0.58% posted its
largest single-day gain for 2005.

While a 61.5-point gain may not seem like much, it was a welcome
reprieve for bulls after a shaky start to 2005.

And you can bet there are some economists burning the midnight
oil as they try and figure out just how the U.S. trade deficit
swelled to a record $60.3 billion in November, after the dollar's
recent weakness.

The rising deficit, despite dollar weakness dampened overnight
enthusiasm that had been set by Intel (NASDAQ:INTC) $23.16
+2.75%, where the company's mentioning that it would increase its
capital expenditures breathed new life into chip equipment
makers, with Applied Materials (NASDAQ:AMAT) $16.53 +2.35%, KLA-
Tencor (NASDAQ:KLAC) $44.45 +4.78% and Novellus Systems
(NSADAQ:NVLS) $26.79 +3.79% giving boost to the Semiconductor
Index (SOX.X) 401.83 +1.42%.

Meanwhile, healthcare looks to be one of 2005's leading sectors
for bullish gains with the Morgan Stanley Health Provider Index
(RXH.X) 402.12 +3.37% lurching its way to an all-time high as
worries regarding provisions for doubtful accounts eased.

Transports were today's lone percentage loser in our U.S. Market
Watch, with UPS (NYSE:UPS) $77.18 -7.34% leading today's weakness
after the company had warned that an unexpected decline in
shipping activity after the holiday would negatively impact
results. Chief rival FedEx (NYSE:FDX) $94.47 -0.98% slid 94
cents by the close, but assured investors that its business
trends remained strong.

U.S. Market Watch - 01/12/05 Close

While stocks did see some volatility today, it was a sharp, and
rather sudden decline in the dollar that will ripple through the
Treasury bond market.

Take some notes today where just after the trade gap figure were
released, the dollar sold off sharply, but so did Treasuries in
the easy going.

Think of this from a simple perspective of supply/demand. Dollar
weakness gives the impression of capital leaving the U.S., where
jumping Treasury yields (selling of Treasuries) gives an added
impression that even the "perceived safety" of U.S. debt suddenly
becomes "risky."

This action had stock futures pulling back from their overnight
highs and then starting to find some acceleration to the downside
as the cash markets opened at 09:30 AM EST.

Market Snapshot / Internals - 01/12/05

We can see some real steepening in the yield curve earlier this
morning. The shorter-dated 5-year yield slid 0.6 basis points,
but the longer-dated maturities found selling. Hey... give an
equity bull a stable dollar trade and that type of steepening in
the curve and they'll probably buy stocks till the nose-ring
makes their nose bleed.

I'm not making any excuse for the major averages to have fallen
lower toward 11:00, but the MARKETS don't like sudden and sharp
moves in currencies, let alone Treasuries.

By lunchtime, things had calmed down a bit, as if an equilibrium
had been found. It wasn't until the bond market closed at 03:00
PM EST that equity buyers put together a little rally, something
that we hadn't really witness in the New Year.

I'm sure everyone would like to know why stocks were able to make
a little push higher. I'll provide my trader's reply, but that
doesn't mean you'll like it.

Answer: Option Expiration

Pivot Matrix -

Three levels in PINK. Today's low. Pretty darned close to where
January "Max Pain" theory had been when the SPX was rising in
December. Today's low also very close to December's Low of
1,173.76. I'll discuss level number two, and both the DIA and
SPX WEEKLY Pivots, as well as a suspicious option trade I just
happened to notice in the DIA today. I would also tie in the
possibility of some "Max Pain" theory with the SPX, as to my
mentioning later in December, as the SPX had risen further, that
January "Max Pain" had moved higher to 1,200.

Tonight, I'll note that fellow analyst Mark Davis, when
commenting on an intra-day pattern he had evidently discussed
earlier this morning in the e-mini S&P futures, pointed to a
POTENTIAL bullish target of 1,194.

And level three, that would be MONTHLY S1. As noted in December
when updated the changing "Max Pain" theories, the increments
were unusually more refined in 5-point increments for January.
It is only tonight that if I were to split a range between 1,175
and 1,200 that my eye is drawn to our MONTHLY S1 for the SPX.

You can read some of Mark Davis' comments regarding the S&P 500
e-min futures to get his perspective on things.

Here's what I saw, and what my thoughts are, in regards to
today's INDU/DIA trade action. I'm trying to remove some of
today's "noise" and news, and figure out just what might be in
play.

Dow Industrials (INDU) Chart - 30-minute intervals

I usually don't point out intra-day head and shoulder patterns
(top, or inverse), but today's observation of a somewhat large
trade in the Dow Diamonds (DIA) Feb. $104 calls (DIA-BZ) at 12:12
PM EST (300 contracts) that came in between the bid/ask at $2.60
got my attention. I was just snooping around, checking option
premiums, and keeping an eye on trades I've profiled in the
Market Monitor.

I mentioned this trade observation (MM 02:45:14 PM EST) and
immediately started trying to figure out what this trader might
be thinking. What is he/she doing? Trading a directional play,
hedging risk, what? I always like to add and subtract the trade
price from the strike price to see if anything "makes sense."

I added and subtracted the $2.60 per contract trade from $104.00,
to derive "targets" of $106.60 and 101.40, while looking to see
"why $104?"

So.. on the above chart of the INDU, this trade would have taken
place after the INDU would have made its now observed "head" and
was bouncing up to its MONTHLY 61.8% retracement of 10,583.81.

While I can never be sure, especially when the trade was made
between the bid/ask (when you trade size the market maker will
usually get you filled in between) I think the trader, maybe a
computer, was buying MONTHLY S1/10,500 higher, then hedging the
risk with an in-the-money covered call (sell the Feb. $104),
maybe, just maybe, factoring in some further weakness into the
end of the month and the Iraq elections.

Certainly I must disclose a bias to my recent profile of selling
two (2) NAKED DIA February $104 calls for $2.75, stop $3.75 on
the option, with a downside objective of $104.00.

Now, look again at the Pivot Matrix. Hmmmm.... it is notable
that tomorrow's DAILY R1 would be within a penny of $104 + $2.60
= $106.60. On a "longer-term basis" $106.60 isn't to far from
January's MONTHLY Pivot for the DIA at $106.74 either.

For me, and especially my previously profiled NAKED put trade,
this becomes a key level where I would expect some selling
resistance.

What does some of this sound like? How about "Max Pain" theory
for a January expiration?

I made comment in December and January regarding the S&P 500
(SPX.X) "Max Pain" theory value, which into the December highs
had moved up from 1,175 to 1,200, in 5-point increments.

It is tonight that I would note today's low of 1,175, and with
such small 5-point increments, yet open interest split rather
evenly from 1,175-1,200. Split the middle (1,187.50) and it may
be no coincidence that MONTHLY S1 might be a point of gravitation
into next Friday.

What I would hope some of the above commentary does for a
trader/investor, is to not have them "thinking too hard," as to
what today's trade gap figures mean.

I would be lying if I didn't say that I was surprised by the
widening gap, and even more cautious from the bullish side.

Begin to question why the dollar was rallying earlier in the
month. Were currency traders buying the dollar, in an attempt to
front-run a narrowing trade gap? Boom! A complete reverse
surprise, a widening trade gap, and the best-laid plans come
undone?

My INDU observations have me LOOKING for an INDU range of 10,400-
10,700 in the context of today's trade gap figures. That's it.

The FACT that I profiled a NAKED call in the DIA with a strike of
$104.00 has me thinking beforehand, that the INDU would be
vulnerable to that level.

Why February and $104 you might ask? With the VIX.X at these low
levels, there isn't a whole lot of premium to be had, and while I
have no inside information that the market's will be jittery into
the Iraq elections, some of the NH/NL internals still suggest
that there's a tendency for softness, where I can envision some
pre-determined pullback into the end of the MONTH.

Let's keep a note of this morning's dollar/bond trade. From a
supply/demand basis, one thing I think an EQUITY BULL does NOT
want to see is further SHARP DOLLAR DECLINE, and SHARP TREASURY
YIELD rising.

For me, this equates to less confidence in the dollar, combined
with less confidence in U.S. Government Debt.

We will also note the weakness in the financial sectors today.
The BIX.X and BKX.X to be more specific, which would be a pretty
good representation of the U.S. banking system.

Personally, I do NOT believe, nor do I see the dynamics for any
type of banking system "crisis." If I do, I be sure to change my
tune, but the major averages will usually follow these sectors
around.